Filkins Fabric Company is considering the replacement of its old, fully deprecia

Question

Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $220,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $97,000 per year; and Machine 360-6, which has a cost of $320,000, a 6-year life, and after-tax cash flows of $93,400 per year. Knitting machine prices are not expected to rise, because inflation will be offset by cheaper components (microprocessors) used in the machines. Assume that Filkins' cost of capital is 12%. Should the firm replace its old knitting machine, and, if so, which new machine should it use?

By how much would the value of the company increase if it accepted the better machine? Round your answer to the nearest cent.
$

What is the equivalent annual annuity for each machine? Round your answer to the nearest cent.

Machine 190-3 $
Machine 360-6 $

Explanation / Answer

Solution : Figures in $ [1] Calculation of NPV: (a) Machine 190-3 PVCO (COST) = 220000 PVCI (PV of Inflow ) = 97000 * PVAF(12%, 3) = 97000 * 2.4018 = 232977 NPV = PVCI - PVCO = 232977 - 220000 = 12977 (b) Machine 360-6 PVCO (COST) = 320000 PVCI (PV of Inflow ) = 93400 * PVAF(12%, 6) = 93400 * 4.1114 = 384005 NPV = PVCI - PVCO = 384005 - 320000 = 64005 machine 360-6 is having higher NPV so to be selected. but equited NPV is considered for decision making By how much would the value of the company increase if it accepted the better machine = $64005 [2] equivalent annual annuity = NPV / PVAF(r% , n) (a) Machine 190-3 = 12977 / PVAF(12%, 3) = 12977 /2.4018 = 5403 (b) Machine 360-6 = 64005/ PVAF(12%, 6) = 64005/4.1114 = 15568 CONCLUSION : As Machine 360-6 is having higher equited NPV so it should be selected.

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